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Thread: IRR in Cost of Debts

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    Default IRR in Cost of Debts

    Hi

    Need help :

    When calcuaing the IRR in cost of redeemable debt how do we determine which Discount factors to use??

    I really have no clue how we figure those out

    Thanks

  2. #2
    harshita Guest

    Default IRR

    The cost of debt capital is the internal rate of return (rate of interest) that equalises the discounted future cash receipts with the current market price.
    Calculation of IRR has to be made using the trial and error method:
    To start this calculation, it is preferable to start with the cost of capital as if the debt was irredemable and then add the annualised capital profit that is expected to be earned on redemption.

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    haha is offline New Member (0-29 posts) haha is on a distinguished road
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    Default

    Quote Originally Posted by Acid View Post
    Hi

    Need help :

    When calcuaing the IRR in cost of redeemable debt how do we determine which Discount factors to use??

    I really have no clue how we figure those out

    Thanks
    Hi

    Just let me put in an example for easy understanding

    if a company have 9% debenture, redemtion in 4 yrs, CT=30%, current MV=$95

    i=9% of $100= $9 (i'm sure you know that for calculation purposes, redemption is value as a block of $100)
    i(1-t)=9(1-0.3)= $6.3
    Redemption value=$100

    I've taught to choose you discount factor around i(1-t) rate, in this case it is 6.3 and we making a gain (redemption value is more than MV) therefore there is likely that IRR will be in between 5-10%. So choose your lower factor @5% and higher factor at 10%.
    It works so far, so hope this can help you.

    Good luck
    Haha

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    mtandon is offline New Member (0-29 posts) mtandon is on a distinguished road
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    Default

    Harshita, just clear one thing.
    I have also read to take the cost of capital as if its irredemable and add the annualised profits.
    Does this makes any difference,, we can arbitarily take any discount rate and see if NPV is > or < 0 and accordingly take another discount rate and calculate IRR.
    isnt this correct.

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    Default

    hi haha and Harshita,

    Like mtandon said that we should choose discount factor of 5-10% for 6.3% as in the example . I have seen many questions in questionbank in which intead of 6.3% we have 12% but still we took DF of 5% and 10% .

    I want to know on what basis should be estimate this in exams?

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    haha is offline New Member (0-29 posts) haha is on a distinguished road
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    Hi Acid

    Yeah! i agree as i done some practice today and realise it does not work. Sorry, that's what i've been told.

    It's don't really matter though as 2 possitive can still give you the same answer, as long as you using the same IRR formula but be safe by using 5 and 15.

    Just wondering if you know we have to work on redeemption yield??? see a question in ACCA exam question book and it back in 98.

    Haha

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    Thank you haha ,

    Whats redemption yeild by the way?

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    haha is offline New Member (0-29 posts) haha is on a distinguished road
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    Angry

    Quote Originally Posted by Acid View Post
    Thank you haha ,

    Whats redemption yeild by the way?
    ahhhh

    There is a small chapter in ACCA text book which talk about all those yield curve and stuffs.
    I just don't know why they put the question in if it's no longer relevant to our paper.
    How's you getting on with your revision? I'm start to get very stress!!!!

    Do you understand how cashflow in perpetuity work? I'm stuck and give up!!

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    Hi

    Revision is going OK. And am stressed too.

    I understand how to calculate cost of equity which involves cashflow in perptuity , is that what you are talking about ?

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    haha is offline New Member (0-29 posts) haha is on a distinguished road
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    Acid

    Yes and it's very lengthy to explain so i gave up.
    I'm stuck in another one today though, business valuation where you have to valuate using DVM, PE ratio, capitalisation and all that sort. Do you know how it works? If so please explain as i find PE ratio as well as Free cash flow technique very confusing.

    Thanks in advance.

    Haha

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